Opting Only In: Corporate Law and the View of Contractarians (Part 2)

We are discussing a paper recently posted on SSRN titledOpting Only In: Contractarians, Waiver of Liability, and the Race to the Bottom and examining the development and use of waiver of liability provisions.    

A widespread view in the academy, and a source of support for Delaware's approach to corporate law, is the idea that corporations are best analyzed as a “nexus of contracts.” In this “nexus of reciprocal arrangements,” the role of the law ought to be to facilitate contracting among the different interest groups that make up the corporation, particularly owners and managers. In this environment, managers, owners, and others bargain for the most efficient relationships, the ones that uniquely reflect the interests of the particular parties involved. Contractarians, therefore, favor enabling provisions where parties can opt in or out and eschew the “one size fits all” approach of categorical rules. Corporate law, in their framework, should merely provide a set of default rules.

The opposition to categorical rules has influenced the view of contractarians on the evolution of corporate law. They see Delaware, where categorical rules have been resolutely replaced by enabling provisions, as a race to the top, that is an evolution that promotes not managerial self interest but efficiency. Under this view, companies choose to incorporate in Delaware because of the efficiency of the legal regimes offered.

The debate over enabling versus categorical rules surfaced with a vengeance in the commentary surrounding the adoption of Sarbanes-Oxley. The Act summarily rejected the contractarian approach, adopting a host of categorical rules. The response was a fusillade of criticism and invective, with at least one scholar labeling the Act “quack corporate governance,” a judgment offered hardly before the ink was dry. Yet as the stock market hit record highs and the number of fraud actions fell, the evidence grew that the categorical approach in fact improved the integrity of the capital markets.

But the contractarian approach had an even more fundamental problem. It simply assumed the conditions necessary for private ordering. Proponents had little to say about the disparate bargaining positions of managers and owners, the problems of collective action and, most critically, the monopoly of management to initiate the process of, or changes to, the opt–in/out process.

Whatever promise of private ordering, therefore, the conditions required for private ordering needed to exist.  That they did not was typically ignored.  Thus, enabling provisions were less likely to result in private ordering and more likely to reflect the control over the bargaining process possessed by management.  This was particularly clear in the context of waiver of liability provisions.